Stocks are essentially shares in a company that the company sells to shareholders in order to raise money. Shareholders are then entitled to dividends if the company succeeds, and might also receive voting rights when the company makes big decisions (depending on the company).
What are stocks?
Stocks play an important role in the global economy, assisting both companies (in raising capital) and individuals (in potentially earning returns). Traders can buy and sell stocks through stock trades facilitated by various stock exchanges. The stock price is determined by supply and demand, largely influenced by the company's success and media representation.
These "units of ownership" are sold through exchanges, like Nasdaq or the London Stock Exchange, under the guidance of regulatory bodies, such as the Securities and Exchange Commission (SEC) in the United States. These regulatory bodies set specific regulations on how companies can distribute and manage their stocks.
What are the different types of stocks?
There are two types of stocks, common stocks and preferred stocks, as outlined below.
Common Stock
Shareholders of common stock typically have voting rights, where each shareholder has one vote per share. This might grant them access to attending annual general meetings and being able to vote on corporate issues like electing people to the board, stock splits, or general company strategy.
Preferred Stock
For investors more interested in stability and receiving regular payments rather than voting on corporate issues, preferred stocks are often the security of choice. Preferred stock are shares that provide dividends but without the voting rights. Like bonds, there are a number of features that make them attractive investments. For example, many companies include clauses allowing them to repurchase shares at an agreed-upon price.
Stock vs bond
Although both stocks and bonds signify an investment, they vary in how they operate. With bonds, you're essentially lending money to the government or a company and collecting interest as a return while with stocks you're buying part-ownership of a company. Another key difference is that bondholders usually have more protection than stockholders do.
In contrast to stocks, bonds are not normally traded on an exchange, but rather over the counter (the investor has to deal straight with the issuing company, government, or other entity).
Stocks vs futures and options
Futures and Options contrast stocks in that they are derivatives; their value is reliant on other assets like commodities, shares, currencies, and so on. They are contracts established off the volatility of underlying assets instead of ownership of the asset itself.
Stocks vs cryptocurrencies
While stocks provide a unit of ownership in a company, cryptocurrencies are digital assets that operate on their own network. Cryptocurrencies are decentralised, meaning that no one entity is in charge, while stocks are shares in companies that are heavily centralised and held accountable for their price movements. Both the stock price and the price of cryptocurrencies are determined by supply and demand.
Another key difference is that stocks are regulated while, at present, cryptocurrencies are not.
Where did stock trading originate?
The first recorded instance of stock-like instruments being used was by the Romans as a way to involve their citizens in public works. Businesses contracted by the state would sell an instrument similar to a share to raise money for different ventures. This method was called 'lease holding.'
The 1600s gave rise to the East India Company (EIC), which is considered by many the first joint-stock company in history. The EIC increased its notoriety by trading various commodities in the Indian Ocean region. Today, we see the limited liability company (LLC) as a watered-down version of the joint-stock company.
How does the stock market work?
The 'stock market’ is an umbrella term that refers to the various exchanges where stocks in public companies are bought, sold, and traded.
The stock market is composed of similar yet different investment opportunities that allow investors to buy and sell stocks, these are called "stock exchanges." The best-known exchanges in the United States are the New York Stock Exchange (NYSE), Nasdaq, Better Alternative Trading System (BATS), and the Chicago Board Options Exchange (CBOE).
Together, these organisations form what we call the U.S. stock market. Other financial instruments like commodities, bonds, derivatives, and currencies are also traded on the stock market.
An example: the New York Stock Exchange
The New York Stock Exchange (NYSE) is the largest equity exchange in the world, and it has a long and rich history. Established in 1792, it was originally known as the "Buttonwood Agreement" between 24 stockbrokers who gathered at 68 Wall Street to sign an agreement that called for the trading of securities in an organised manner.
Since then, the NYSE has become a global leader in financial markets, with more than 2,400 companies listed and nearly $26.2 trillion in market capitalization. The exchange has an average daily trade volume of $123 billion.
Investing in common stock or preferred stock on the NYSE can be done through a broker or online stock trading platform. When trading on the NYSE, investors have access to a wide range of products and services, including stocks, bonds, mutual funds and ETFs (exchange-traded funds).
Investors can also take advantage of the numerous benefits that come with trading on the NYSE, such as access to real-time information and the ability to buy and sell quickly. The trading platform is regulated by the U.S. Securities and Exchange Commission (SEC).
How to navigate stock market volatility
Stock market volatility, characterised by rapid and unpredictable changes in stock prices, is influenced by economic indicators, geopolitical events, and investor sentiment. To manage this volatility, investors can diversify their portfolios, set clear investment goals, and maintain a long-term perspective.
Regular portfolio reviews and seeking guidance from financial advisors can also help when it comes to making informed decisions during volatile periods. Investors who stay informed about market trends and use strategic approaches can navigate market fluctuations more effectively, which better positions them for long-term success in stock investing.
The importance of diversification when investing
Diversification is key when investing, and the stock market is no exception. The "don't put all your eggs in one basket" approach offers benefits like risk reduction and the potential for higher returns. Strategies for diversification include investing across different sectors, industries, and asset classes.
By spreading investments, investors can manage risk effectively, ensuring their portfolio isn't overly exposed to any single asset or market sector. This helps cushion against market downturns and enhances the overall stability of the investment portfolio.
Terminology associated with the stock market
- Broker: A broker is someone who buys and sells assets on behalf of another person, charging a commission for their services.
- Stockholders equity: The value of a company's stock can be better understood by this metric, which is the company's assets remaining after all bills are covered (liabilities).
- Stock splits: Conducting a stock split is one way that companies make their stocks more accessible to investors. Although it won't change the market capitalisation or value of shares, it will increase the number available.
- Short selling: If an investor wants to bet on a stock's price going down, they can take a "short" position. To do this, they must borrow the stock from either a broker or a financial institution.
- Blue-chip stocks: Companies that are large and have a lot of capital typically fall into the blue-chip category. They usually trade on famous stock exchanges, like the NYSE or Nasdaq.
- Pink sheet stocks: 'Penny' or 'pink-sheet' stocks are those that trade below the $5 threshold and are typically OTC (over the counter). These can be high risk.
- Buying on margin: Buying on margin is using borrowed money to buy stocks, bonds, or other investments in the hopes of making big returns and paying off the loan.
- Market order: When placing an order for a trade, the investor needs to pick from several types of orders. A market order is executed at whatever the next price is, which can be risky if there's a big gap between what buyers and sellers are offering.
- Limit order: A limit order is an order to buy or sell a security at a specified price, with a maximum amount decided on before executing the trade.
- Stop order: A stop order, also referred to as a stop-loss order, is an order placed with a broker to buy or sell once the stock reaches a predetermined price.
In conclusion
Shares, or stock, are units of fractional ownership in a company that investors buy to gain capital appreciation and tap into a company's earnings if the company's stock pays dividends. Companies, through listing their stock on an exchange, can raise capital to further develop the business.
Stock is traded on an exchange, and the stock prices are determined by supply and demand.
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